Transcript No Slide Title

Contemporary Financial
Management, 10th Edition
by
Moyer and McGuigan
Prepared by
Michael J. Alderson
Saint Louis University
©2006 Thomson/South-Western
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The Role and Objective of
Financial Management
Introduction

This chapter introduces the financial
management process of the typical firm. It
looks at the field of finance, various
financial decisions and their implications,
and the daily questions faced by the firm’s
financial managers.
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Questions Faced by Financial
Managers

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Will a particular investment be
successful?
Where will the funds come from to finance
the investment?
Does the firm have adequate cash or
access to cash to meet its daily operating
needs?
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Things to Think About

How is finance related to other fields of study?

What are the goals and objectives of a financial
manager?

How has the finance field evolved over history?

How is the field of finance changing today?

More questions are listed in the text.
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Principal Forms of Business
Organizations

Sole proprietorship

Partnership

Corporation
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Sole Proprietorship
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Owned by one person
Easy formation: advantage
Unlimited liability: disadvantage
Difficulty raising funds: disadvantage
Represent 75 percent of all businesses
Account for less than 5% of total business
revenues
For more information from the SBA, go to
http://www.sba.gov/
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Partnership

Owned by two or more persons

Classified as general or limited

Partnership dissolves when a general
partner dies: disadvantage
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Liability of Partners

General Partner
Has unlimited liability for all obligations of the
business: disadvantage

Limited Partner
Liability limited to the partnership agreement:
advantage
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Corporation

Limited liability

Flexibility

Permanency

Legal entity

Ability to raise capital


Has a board of directors
Easy marketability
of shares of
ownership

Owners are
stockholders
All advantages
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Board of Directors

Stockholders elect a board of directors

Board of directors then elect the officers
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Chairman of the board
Chief executive officer (CEO)
Chief operating officer (COO)
President
Chief financial officer (CFO)
Vice presidents
Treasurer
Secretary
Management
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Who Does What?

Board of directors
deals with broad
policy

3 to 5 year strategic
plan

Management makes
most of the
decisions

Day-to-day decisions
following the
strategic plan
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Stockholder Rights

Dividends

Asset

Voting for board members, major policy

Preemptive rights on new shares
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Priority of Corporate Securities
Debt Securities (Bonds)
(highest)
Preferred stock (P/S)
Common stock (C/S)
(lowest)
Major corporate Web sites
http://www.ford.com/
http://www.gm.com/
http://www.porsche.com/
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Optimal Form of Organization
Influenced by

Cost

Complexity

Liability

Continuity

Raising capital

Decision making

Tax considerations
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Shareholder Wealth Maximization
Objective of
financial
management
Shareholder
Wealth
Maximization
(SWM)
Objective of the
financial manager
NOT
Profit maximization!
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SWM

Considers the timing and risk of the
benefits from stock ownership

Determines that a good decision
increases the price of the firm’s common
stock (C/S)

Is an impersonal objective
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Is concerned for social responsibility
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Social Responsibility
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To sustain an optimum return on investment
for stockholders
To be perceived by customers as a provider
for quality service
To demonstrate that employees are our most
valued resource
To provide corporate leadership to our
community
To operate in compatibly with environmental
standards and initiate programs that are
sensitive to environmental issues
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Divergent Objectives


Problem
created by
separation of
Owners (shareholders)
Management and
Employees
Management may maximize
its own welfare instead
of the owners’ wealth.
Job security
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Job Security


Management decisions based on
retaining management rather than SWM
Example


A decision to retain suppliers rather than
selecting new suppliers providing higher
quality and/or lower cost
Why? If a change is made management will
be scrutinized, but if no change is made,
the issue will be ignored
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More Divergent Objectives
Problem created by
separation of
Owners
Creditors
Caused by conflicting interests
concerning risk and returns
Protective covenants
in loan agreements
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Examples of Protective Covenants

Limitations on

common stock dividends
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the type of investments
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divestitures

poison puts
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additional debts
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Agency Costs
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Corporate governance
Management compensation
Threat of takeovers
Recent Development
• Sarbanes-Oxley Act
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Shareholder Wealth Maximizing is
a Market Concept and Results in

Maximizing PV of E(R)
Important note!

Success is measured by Market Value of
Common Stock---

Not by profit maximization!
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Limitations of Profit Maximization

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Static nature of standard microeconomic
model (Lack of time dimension)
Variable definition of profit
Provides no direct way for managers to
consider the risk of alternative decisions
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Three Basic Factors Determine
C/S Market Value

1) Amount of
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2) Timing of
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3) Risk of
Expected cash flows
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Conditions affecting market value
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Economic environment factors
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Decisions under management control
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Conditions in financial markets

Expected cash flows
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Managers deal with these
competitive forces
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New entrants
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Substitute products
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Bargaining power of buyers
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Bargaining power of suppliers
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Rivalry among current competitors
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Cash flow generation
Raise Funds
-External
-Internal
Acquire Assets
-Long-term
-Working capital
Funds for investments
Funds to distribute
Produce and Sell
Products/Services
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Cash Flow Concept central to:
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
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Financial analysis
Planning
Resource allocation
CF does not equal accounting profit
Internal sources
Cash
External sources
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NPV of an investment

NPV = PV of future cash flows
minus cash outlays
The NPV of an investment
represents the contributions of
that investment to the value of
the firm and passes on to SWM.
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Controller’s Activities

Financial accounting

Cost accounting

Taxes
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Data processing
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Treasurer’s Activities

Management of cash and marketable
securities
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Capital budgeting
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Financial planning
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Credit analysis
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Investors relations

Pension fund management
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Disciplines Impacting Finance
Economics
Accounting
Marketing
Production
Human Resources
Quantitative
Analysis
MIS
Finance
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Professional Organizations
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Financial Executive Institute
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Institute of Charted Financial Analysis
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Financial Management Association
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Institute of Management Accounting
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Exciting Career Opportunities

VP of Finance

Financial Analyst

Director Investor
Relations

Account Executive
Security Broker

Assistant Treasurer  Mortgage Analyst

Tax Manager

Banking
Check out http://www.careerpath.com/
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Different Size Businesses
Small Business
vs.
Large Corporations
Fundamental concepts are the same
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Small Business
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Not the dominant firm in the industry
Tend to grow more rapidly
Limited access to financial market
Lack management resources
Have a high failure rate
Stock is not publicly traded
Poorly diversified
Owner/manager frequently the same
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